A variety of different types of contracts are traded on various exchanges and other markets throughout the world. A cash contract is a sales agreement for either immediate or deferred delivery of the actual equity or commodity. An option is a contract that conveys the right, but not the obligation, to buy or sell a particular equity, commodity or futures contract on an equity or commodity at a certain price for a limited time. A call option is an option that gives the buyer the right, but not the obligation, to purchase the underlying equity, commodity or futures contract at a certain price (known as the strike price) on or before the expiration date. A put option is an option that gives the option buyer the right, but not the obligation, to sell the underlying equity, commodity or futures contract at the strike price on or before the expiration date.
A futures contract is a legally binding agreement, typically entered into on or pursuant to the rules of an exchange, to buy or sell an asset (such as an equity or a commodity) sometime in the future. An equity is generally an ownership interest in an asset such as stock in a company. In a narrow sense not intended for use herein, futures, options, and stocks are contracts for products traded on formally organized exchanges.
A derivatives contract is a financial instrument, the value of which is linked to the price of an underlying such as a commodity, asset, rate, index or the occurrence or magnitude of an event. A commodity is generally an article of commerce or a product that can be used for commerce. The types of commodities commonly include agricultural products such as corn, soybeans, and wheat; precious metals such as gold; fuels such as petroleum; foreign currencies such as the Euro; financial instruments such as U.S. Treasury securities; and financial indexes such as the Standard & Poor's® 500 stock index, to name a few. Standard & Poor's® 500 stock index is disseminated by Standard & Poor's, 55 Water Street, New York, N.Y. 10041. Unlike cash commercial contracts, futures contracts very rarely result in delivery, because most are liquidated by offsetting positions prior to expiration. Typical examples of derivatives contracts include futures, forwards, options, swaps, and swaptions, and these can be combined with traditional financial instruments, investments, and loans to create hybrid financial instruments.
At one time, there were only open-outcry exchanges. An open-outcry exchange is a public auction system that involves traders standing in a trading “pit” and calling out prices and quantities that indicate their willingness to buy or sell, so that the information is available to all traders. Open-outcry traders use hand signals to convey the same information; otherwise, it would be difficult to hear with so many people shouting at the same time. Open outcry is an efficient means of “price discovery,” allowing purchasers and sellers to arrive at the best prices given the supply and demand for a tradable object.
Pit trading is increasingly augmented and sometimes replaced by electronic trading systems that process automatic and electronic matching of bids and offers. The desire for immediacy of order execution and dissemination of information is one reason for the steady switch to electronic mechanisms. In recent years, the popularity of electronic trading has caused market share to rapidly migrate from the open-outcry exchanges to electronic trading. Thus, trading methods have evolved from a manually intensive process to technology enabled, electronic platforms.
Generally, electronic markets have replaced direct liquidity with market access—where access is mostly available at the bid or ask prices, which have created a much faster trading environment. The imbalance related to entry is now always present so by trading “with” the market, traders are able to profit from price fluctuations while simultaneously adding default liquidity. Default liquidity arises when there has been enough repeated trade at surrounding prices to cause an increased availability to access. Imbalance rather than efficiency is the major change that has structurally occurred due to electronic trading as time—the needed ingredient for efficiency—has been curtailed.
Electronic trading is generally based on centralized (host) computers, one or more computer networks, and exchange participant's (client) computers. In general, the host exchange includes one or more centralized computers. The operations of the host exchange typically include order matching, maintaining order books and positions, price information, and managing and updating the database for the online trading day. The host exchange is also equipped with external interfaces that maintain contact to quote vendors and other price information systems. Software running on client devices allows market participants to log onto one or more exchanges and participate in the market. Using client devices, market participants or traders link to the host exchange through one or more computer networks.
The processing of volume today has been keyed to accumulation differentials at various prices throughout an assigned timeframe, such as for example a minute, hour, day or week, etc. Studies related to this output use accumulation as a basis, and as volume grows displaying it in multiple and more revealing formats within the limited screen space available in the matching engines becomes very difficult. In addition, as volume grows allowing a trader to visualize the data into distinct visual segments becomes very difficult due to the overlapping nature of continuous accumulation related to various market stimuli. Versus just being an accumulate and used as an adjective to help define price, it would be advantageous for volume to stand alone and offer far deeper insights to market activity as an equal or greater than reference to price—one could actually arbitrage volume to volume and as well as volume versus price, instead of the more traditional arbitrage of price to price.
Markets have an inherited complexity that precludes using the concept that the whole has any working parts except price, and further that the resultant prices are fair and balanced, which they are not. The unwritten axiom related to anything financial is that outcomes will always be less than needed versus normal expectations, and it is a function of a lack of understanding of the working nomenclature of markets that brings this to bear. Market efficiency, zero sums, etc. as claimed by academia, and in general, the skeleton reporting of market activity as price has further entrenched that the whole is just one summary price.
Markets in their development are a lot more than the finalized reported output, financially speaking. In the latter, such output is slightly less than one-to-one, while in reality the real output is much greater due to internal leveraging of time and repeated usage of parts of its developed range. This enlarged base is made up of price rotations within that range due to liquidity, supply imbalances related to volume dispersal around larger prices, new range developments to provide continued access, movement of volume away from current area of usage to a new one within an already established range, the movement away from any or all of the above, and finally the use of the trade in relationships to other markets.
If a market has a reported range of a certain number of dollars, the settlement price segments it to much less, the net change from a previous price is again most often less than that period's range, which sets up the notion that that value is less than one-to-one operatively while the hidden sub-parts add up to more than that total. Categorizing the above developments into a progressive order can and does define specialization of market development, and rotation and leverage allow greater than normally reported differentials—repeating a trading range is in total always greater than the reported singular output, leverage in other zones provide ways to defeat time costs normally associated with the whole, and external uses offer additional range as well as leverage, all of which provide a greater than opportunity base.
There are many zones of activity within a market's development and most overlap each other's activity, thus making a clear distinction of such defined areas very difficult. In the past, where price efficiency ruled, it was impossible to make a clear distinction as to what or why the market was doing as the overlap was total, and therefore by default price was the lone readable instrument. Separation of both buying and selling activities has emerged in the markets as of late, and the overlapping of trading zones, which used to be total, is now far more separate. This overlapping, which has caused people to look at the whole of development as singular rather than plural, makes the emphasis on its ending position versus how it got there. This new separation related to data offers traders a consistently true economic advantage that at best was just sometimes available in the past.
Specialization within the trading venue has been one of the main reason markets were efficient as (a) price(s) offered at the bid or ask always could be used to an advantage in some trader's program—where each of the traders defined their respective zone of activity by their participation. Specialization in trading fostered competition within this singular yet plural approach, but more importantly offered different and differing advantages to all programs at the same time. This broader framework created a very competitive marketplace, which in turn served the market well as all this activity was at the beginning of activity that produced the resultants of price or prices that were then broadcast to the world at large for any and all possible uses.
The market always started with a relatively large but still quite small overall range that usually was further defined by extensions at one end and then progressed to a fair traded area or price zone that met the goals of most users. If the market-established range was wrong or new information was evident in the sense that supply or demand was out of balance, the market would then move further in one direction to find a new balance or an equilibrium that would serve as a new base. Lastly, the market would traverse any established value range to attract business and bring additional external buying and selling from those margins because of perceived advantages to their usage at the various prices offered during those rotations—in other words, facilitating trades.
Traders would approach the market from any of the following steps: they would trade price-to-price; they would trade price/quantity to price; they would trade leverage (leverage being defined as an internal relationship of time and price) to price; they would trade price to leverage; they would trade leverage-to-leverage, all as conditions warranted or would await just their own specialty. In addition, trade would migrate to time spreads between contact months or go to contracts outside of the immediate contract—all of which makes the opportunity base far greater than that less than normally associated to the information costs long associated with defining and using the markets as a singular price entity.
Some zones of trade activity were skipped and others were never reached—due to lack of trade or too much trade. Traders needed to trade in step within their respective zones with whatever market development was happening, and be able to stop, avoid or restart into any new category as the disciplines as well as opportunities were changing and therefore becoming different and difficult to analyze. A trader does not want to get lost on a whole as any definitive advantage will have disappeared. In open-outcry markets all this activity was a great deal more transparent to those in the trading pits. Today, with electronic trading dominating the various activities, this type of transparency is missing along with the many different zones of trade activity, which in turn has amplified volatility. There is a big difference in liquidity—which offers a form of immediate replacement—and that of access—which offers availability only at that moment in market history. The difference in price access can be large or small while liquidity offers repeated means of access as discussed previously—access offers that same chance to much lesser degree. The net effect of liquidity on markets was vertical stability as vertical risk was laid off into many various venues rather than remaining in the singular. While providing access, electronic platforms do not offer substitution and thus its vertical price platform is very unstable. Liquidity also brought supply and demand forces together within an immediate price through this same substitution, and one must note that these two dominate market forces were always functioning with a pronounced time lag—one always occurred before the other, and it should also be noted that the lessening of liquidity is responsible for the market separation that we see today.
Volume today is a means of getting information related to access imbalance due to supply or demand forces being separate as volume is accumulated and tabulated as it occurs on electronic trading platforms. Trading today is more reactive as access is mostly available to all trading zones as a singular format, which has had the effect of removing time and therefore speeding up the market. So instead of price being universal, it is access today that offers only one size for all and that size is mostly vertical in nature. The tone of the market is not varied as in the past as the one-price-fits-all for access forces the market into a monotone of fast to impossibly fast related to price or no trade interest at all—making prices and the resultant pricing scale a very unstable part of the market versus the past. In the past, the vertical part of the market used multiple developments and limited retracement of those price ranges within each instance as a force for vertical stability; today, the cost of using access as a singular force has eliminated time and replaced it with more range seeking properties in each direction. The resultant zones of trading activities are then formed more as an eventual resultant than being a focused development as in the past.
Volume accumulation at each trade price provides an earlier read of the in place as well as future imbalanced development zones that represent the blueprint of vertical market activity today. Volatility is born as a result of forced reactions to price activity versus the more defined opportunities of the past that resided within a limited range of price development (value areas). A trading interface that enabled users to read volume earlier and clearer would provide an economic opportunity outside the singularity of the present price, and this broadened base would in turn stabilize the vertical base of markets by defining each zone of separation, thereby allowing specialization to again be a force within development.
Volume is conveyed in an accumulative format where the sheer size of volume makes reading the data extremely difficult beyond the whole of it at the end. Volume has been broken down into categories of the amount of buying at the bid versus selling at the ask as well as other singular insights, but as markets are moving to all entries being the same, the net of that net is quite small and those types of differentials will not be long-lasting information sources. Volumes from markets open day and night have a problem with its variance related to trade magnitude differentials when incorporating them as a whole as those merged data need to be distinguished yet included.